Examine democratic and budgetary crises across the world and you’ll find a running theme – tax havens. Let’s take a look: in the last three years alone, in France the budget minister has had to resign because he had cheated on his taxes for 20 years through unreported offshore accounts. In Spain, the former treasurer of the party in power has gone to jail after having revealed a hidden system of financing through Swiss banks. In the United States, Congress has revealed that Apple avoided tens of billions in taxes by manipulating the location of its profits, at a time when US infrastructure is crumbling.

Accepting the status quo seems irresponsible.

Last week, the OECD released a plan to address some of the issues raised by offshore tax havens. The plan is designed to curb the growing shifting of corporate profits to Bermuda and other zero-tax countries, such as the British Virgin Islands and Cayman Islands. This effort, along with other recent initiatives, must be commended. But it is insufficient, because it fails to address the core problems raised by tax havens. Our corporate tax rules, decided by the League of Nations in the 1920s, have not been adapted to an age in which CEOs see it as their duty to dodge taxes and a world where a web of tax havens obliges.

Why is today’s corporate tax broken? According to the principles set forth by the League of Nations, taxes on corporate profits are to be paid to the country where profits are made. If Google manages to report profits in Bermuda, this income is taxable in Bermuda, where the tax rate is a modest 0%, even if no sales are made in Bermuda, if no office stands there or if no one works there. Now there are numerous ways for firms to shift the location of their profits to Bermuda artificially. This is the miracle of transfer pricing.

Transfer prices are the prices at which multinational firms exchange goods and services internally. In principle, according to the League of Nations’ rules, intra-group transactions should be conducted at the market price of the good or service traded, as if the subsidiaries were unrelated. In practice, transfer prices are routinely manipulated by armies of accountants. There are billions of intra-group transactions every year and tax authorities cannot possibly monitor all of them.

In addition, in many cases, there is no relevant market price, giving firms full latitude to choose the price that will minimise their tax bill. What was the “market price” of Google’s technologies when it transferred them to its Bermuda subsidiary in 2003, before it was even being listed as a public company?

Until recently, we did not have a clear view of the extent of corporate tax dodging. With few exceptions, economists have not been particularly interested in the role that tax havens play in the global economy.

There have been numerous journalistic investigations, which have pushed forward our understanding of the tricks used by multinational firms, but from careful case studies it is hard to infer the overall cost to government coffers.

In my new book, The Hidden Wealth of Nations, I try to fill this gap. I gathered the available data sources on the international investments of countries, the balances of payments, the on- and off-balance sheet positions of banks, the wealth and income of nations, the accounts of multinational companies and more.

Some of these statistics have never been used before and this is the first time that all this information has been collected, confronted and analysed with a single objective: to expose the true activities of tax havens and their costs to foreign nations.

What if Apple was taxed according to where it sold its goods? Photograph: Paul Sakuma/AP

The results are striking. The artificial shifting of profits to offshore tax havens has reached extreme levels over the last years, with 55% of the foreign profits of US firms now “made” in a handful of almost zero-tax countries . That’s 20% of all US corporate profits, both domestic and foreign, a tenfold increase since the 1980s. Silicon Valley giants have been particularly innovative when it comes to dodging taxes.

While the US federal government hasn’t changed its nominal tax rate on corporations since the late 1980s – it has remained at 35% – the rate that US firms actually pay has declined to 20%. The available evidence suggests that the trends are similar in other countries: everywhere, firms have the same incentives to shift as much profits as they can to offshore havens.

Because no one openly condones illegal tax evasion, the proponents of profit shifting argue that it’s all legal. Yet the European Commission has opened an investigation on the tax deals offered by Ireland and Luxembourg to companies such as Apple, Amazon, Starbucks and Fiat. What was said to be “legal” might turn out to not quite be so. The proponents of tax dodging also say that less tax on businesses means more investment and more jobs. This misses three things.

First, the taxes avoided by big companies have to be compensated for by higher taxes for the rest of us – higher income taxes on the middle classes and higher sales or property taxes for everyone, unless we cut spending on education, health and infrastructure.

Second, tax avoidance distorts competition; big firms get away with low tax rates because they can operate all over the world and can afford the pricey services of the big accounting firms, while nascent businesses have to face the statutory rates. This unfairness rigs the functioning of markets.

Yet the fundamental problem is that corporate tax avoidance increases inequality. Corporate taxes are one of the main way to tax capital. In Europe and the United States, about one-third of all capital tax revenue comes from corporate income tax, the rest comes from property taxes and individual taxes on dividends, interest, capital gains, estates and inheritances. When corporations skirt the tax system, they reduce the effective taxation of capital. Because capital is very unequally distributed, this reduction benefits only the wealthiest among us.

Corporate tax dodging is then tantamount to upward redistribution. A reduction in capital taxation also means higher rates of return for capital owners. History teaches us that higher rates of return tend to be associated with more wealth inequality down the road.

Amazon is famous for avoiding tax on its vast global sales. Photograph: EMMANUEL DUNAND/AFP/Getty Images

What can be done?

The OECD plan that was agreed upon last week is useful because it may make it harder for firms to shift profits to tax havens. However, it falls short in two key areas. It fails when it comes to transparency. Although it calls for multinational companies to compile country-by-country accounts of their profits, sales, and employees, these accounts will not be publicly disclosed. Citizens, consumers, journalists and researchers will have no way of knowing which firms shift their profits offshore. More fundamentally, the OECD retains the flawed framework of transfer pricing, which makes it too easy for corporations to escape taxation.

The good news is that corporate tax avoidance has a solution that is technically simple, proved to be effective and requires little international cooperation. Instead of taxing the subsidiaries of multinational groups as if they were separate entities, corporations should be taxed on their consolidated global profits.

Apple made $50bn in profits globally last year: this figure is known and hard to manipulate; it is the right starting point. We then need to find a way to allocate profits to each country. One easy way is to allocate profits proportionally to where sales are made. Let’s imagine that Apple made 10% of its sales in the United Kingdom. Therefore, 10% of its global profits, or $5bn, would be taxable in the UK.

Corporations can move their profits all over the world, but they can’t move their customers: they are in the US, the UK or Germany, not in Bermuda. That’s the beauty of the reformed corporate tax system, known as formula apportionment, that I’m supporting.

Is this idle fantasy? Not at all: this is exactly how US states tax US companies with activities across the country.

Profits within the United States are apportioned to California or New Jersey based on the share of US sales made in these states. In this way, a corporation can’t claim that its profits were all made in tiny Delaware (population 935,000), where the corporate tax rate is 0%.

No tax system is perfect and America’s is no exception. However, it has been in place for decades, has a reasonably good track record and no one would ever imagine abandoning it in favour of the international transfer pricing model supported by the OECD.

Extending the US system to the international stage would make it impossible for Bermuda or Luxembourg to steal the tax bases of countries where economic activity actually takes place.

How do we get there? The UK could tomorrow unilaterally decide to tax multinational firms using an apportionment formula, without asking permission from anyone. The relevant information already exists: we know the global profits and sales of firms and it is easy to track the location of their sales. In that sense, corporate tax reform does not require a great deal of international co-operation.

More co-operation, however, is always better and it turns out we have a unique opportunity to reach an international deal.

The US and Europe are currently engaged in discussions to establish a transatlantic trade and investment partnership (TTIP) and the US has similar talks with Asian economies. These free-trade talks are the right platform to reform corporate tax.

It makes no sense to talk free trade in 2015 while totally disregarding tax issues. Further trade liberalisation should be conditional upon reaching an international agreement on how to tax the Amazons, Apples and Googles of the world. Concretely, as part of TTIP negotiations, the EU and the US should agree on two simple things: a common definition of corporate profits and a fair rule for apportioning the profits of firms across the Atlantic, for instance, based on the location of sales.

Jean-Claude Juncker, another president of the European Commission from Luxembourg Photograph: Michele Tantussi/Getty Images

Tax havens such as Luxembourg and Ireland have an incentive to maintain the flawed status quo. For years, they have been blocking attempts to move to an apportionment system within the European Union. The benefits of stealing other countries’ revenues can be quite large indeed. Doing so helps attract a little bit of real activity, such as accounting firms, lawyers and financiers.

More importantly, it boosts the importance of offshore centres on the international stage. Luxembourg is a case in point: the Grand Duchy has one thousandth of the EU’s population, yet this is where two of the last five presidents of the European Commission come from.

There is a growing demand for transparency and reform among EU citizens. The United States already uses formula apportionment internally; it sees the virtue of this system. It is the responsibility of EU countries to forge an agreement. It took decades for the European Union to convince Luxembourg to partially abandon banking secrecy. Do we have to wait decades for corporate tax reform to occur?

An alternative approach involves threatening with economic sanctions the countries that want to facilitate tax avoidance and evasion. One type of threat would be trade tariffs, proportional to the costs that unco-operative tax havens impose on the governments of foreign countries.

Like most economists, I favour free trade: I believe it spurs growth and innovation. But if free trade means widespread tax dodging, rising inequality and tax unfairness, it has no future. The good news is that globalisation and tax justice are not incompatible. If we put taxes back at the centre of TTIP and other free-trade talks, we can quickly and thoroughly reform corporate tax and make widespread tax dodging a thing of the past.

Gabriel Zucman is assistant professor of economics at the University of California, Berkeley. He is the author of The Hidden Wealth of Nations: The Scourge of Tax Havens